Fair Value – Friend or Foe? Lauren Power – Assurance Manager
August 2008
acknowledged. Standard setters support the As the world’s financial markets continue to application of IAS 39. By reporting assets at current tread a rocky road, it’s an uncomfortable time market values, financial statements are disclosing the true economic position - they are after all intended to for many of us in the finance industry, waiting to reflect the situation at the reporting date, not a see how strongly the credit crunch will impact probable or possible future one. on our industry locally. That may be, but until recent events unfolded, very Body As often happens at times of crisis, the search is few commentators argued against booking gains as on for a scapegoat and at present,‘fair value’ is a markets steamed ahead. So the question could be popular choice. Recent months have seen a diverse asked - why not hold at cost? Cost will tell you what range of opinions from investors, regulators, standard you paid for it however it does not provide users of setters and commentators on the wisdom of valuing financial statements with information about future cash assets held for long term purposes using current flow prospects of the instruments. market values, thereby including the full impact of the current, exceptional, market circumstances. The Though critics may make attempts at blaming fair rationales may change and develop almost weekly, value, the market consensus seems to accept that but there are voices consistently arguing that had financial reporting, including the application of fair assets been valued at cost, the economic downturns value, does not create adverse market conditions, we are experiencing would have been more easily rather, it captures the market performance after it has controlled and corrected. occurred.
So what exactly does ‘fair value’ stand accused of? Whilst it may be said that the application of fair value Since its introduction under International Financial during periods of volatile market activity escalates the Reporting Standards, fair value, primarily considered number and magnitude of write downs in the within IAS 39, has undeniably been a highly marketplace, supporters see this as part of its role in demanding standard as it requires trading assets to be increasing the transparency of the impact of market valued using active market prices. Applying the forces on financial performance, which investors prefer principles of fair value and marking-to-market in a – deferring bad news does not create investor falling market can arguably make businesses look confidence. weaker than they really are. Businesses are reporting on the effect of hypothetical transactions in the current Another question asked by fair value critics is whether market, rather than using more "realistic" values based there should be circumstances where we suspend ‘fair on management estimates of eventual outcomes. value’. Perhaps the theoretical purity of marking-to- market should be tempered to reflect that not all We have seen many clients writing down what they assets need to be disposed of immediately and consider to be perfectly good assets to exceptionally therefore why value them as such? Standard setters low values because the market price is currently such as John Smith of the International Accounting depressed, even though they have little or no intention Standards Boards are adamantly against this, stating of transacting at that price. This can lead to a pro- that it would only delay the bad news: “By denying this cyclical effect as each time a seller transacts at a information to the marketplace the real problems lower price in the market place, all holders of that would not have been discovered until a year or two asset are forced to write down the value of the asset to down the road and the problem would have been the last traded price. worse.”
Some of our clients and other commentators believe The IASB have no doubt that fair value is an essential fair value accounting is accelerating and exaggerating step forward from a transparency and disclosures some of the bad news in the market. They will argue perspective, stating in a discussion paper released in that if you can hang on to the assets and ride out the March 2008, that “fair value is the only appropriate storm, there will be reversals of the current provisions measure for all types or financial instruments.” in the next cycle. However, it does acknowledge that “there are issues and concerns that have to be addressed” in relation to The benefits fair value has brought in terms of its application. transparency and comparability must also be pwc.com/jg Fair Value – Friend or Foe? Lauren Power – Assurance Manager
August 2008
Significantly the IASB is engaging with the financial services industry to see if it can refine or redefine the valuation models. In May 2008 it formed an expert advisory panel comprising industry representatives from banking, accountancy and investment management sectors and including an observer from FASB, the US Standards Board. Its remit is primarily to discuss how to measure the fair value of financial instruments when markets are no longer active.
The panel recently met to discuss a summary of the issues encountered in the credit crisis, IAS 39’s requirements and guidance with regard to those issues and a summary of how the panellists have dealt with the issues in practice, focussing on the processes and approaches used when measuring the fair value of financial instruments when there is no longer an active market. A sub-group of the panel has also met specifically to discuss how disclosures could be improved to provide transparency about fair value measurements in the current market environment.
Standard setters and capital markets participants need time for reflection, analysis and debate far beyond the closed doors of the IASB sub panel, before evaluating whether fair values should be used more widely. As discussions spiral to open up issues including a possible role for standard setters in working with other regulators and companies to help restore confidence in markets, we believe more time is needed to respond to the present challenges before considering whether to extending the use of fair value beyond where it stands today.
The credit crisis has highlighted the benefits of reporting fair value for financial instruments and exposed certain limitations. Despite its imperfections it remains the best available method for most financial instruments.
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